Monday, August 30, 2010
Associated Press
NEW YORK
With the market down three weeks in a row, investors are understandably grim. But there is a silver lining: Stocks are looking almost as cheap as last year when prices hit 12-year lows — at least according to Wall Street analysts.
It was easy to miss the development amid news of falling home sales, a drooping dollar and sluggish orders for big-ticket goods. But stocks in the Standard & Poor’s 500 index now trade at just 11.7 times analyst estimates of operating earnings for the coming year. That is one of the lowest — read cheapest — levels for this key figure.
In fact, this so-called price-earnings multiple is roughly back where it stood at the end of March 2009 just as the market was starting an 80 percent surge.
A lot of investors are kicking themselves for missing that run-up. The question now: Should they jump in now to not to miss another?
Though it’s a rough measure of a stock’s value, the earnings multiple has a certain logic. Before buying the corner pizzeria, you’d want to know how many years it would take selling pies and sodas to earn your money back. You do that by dividing the price you’d have to pay for the business by the profit it generates over a year.
So too with stocks. The earnings multiple divides stock prices by annual earnings to tell you, in a sense, the number of years it might take to be made whole on your investment. The nearly 12 years that analysts say it would take if you bought stocks now compares with an average of maybe 15 over the past two decades.
But the faster clip assumes actual profits won’t fall short of the projected ones. Some longtime market observers are worried about that.
“Some analysts are projecting earnings will hit an all-time high in a year,” says Howard Silverblatt, senior index analyst at Standard & Poor’s. “That would be nice but I wouldn’t bet on it.”
History suggests he’s right to be skeptical.
An April study by McKinsey & Co. of analyst projections over 25 years showed they are almost always too optimistic. On average, analysts estimated that profits would grow at 10 percent to 12 percent annually — almost twice as much as they actually did.